How a Rate Cut by the Bank of England Could Influence the US Economy

England’s central bank cut its key interest rate for the first time in four years Thursday, even as the U.S. Federal Reserve continues to search for the right time to scale back rates.

The Bank of England cut interest rates a quarter-percentage point to 5% after inflation there had fallen to its target of 2% inflation in May and June.  This decision follows similar moves by the European Central Bank and Bank of Canada, showing that economies around the world are scaling back interest rates as inflation becomes more controlled.

After nearly dipping into a recession in 2023, the U.K. economy has recovered some this year. Economists at Wells Fargo forecast that the gross domestic product (GDP) there would grow by about 1% this year. 

“Although GDP has been stronger than expected, the restrictive stance of monetary policy continues to weigh on activity in the real economy, leading to a looser labour market and bearing down on inflationary pressures,” the central bank said in a statement accompanying the decision.

When the U.S. began raising interest rates to battle spiking inflation, other members in the Group of Seven economies also moved rates higher, partly to stay in line with the Federal Reserve. But as economic growth has slowed, more central banks are moving forward with rate cuts, even as the Federal Reserve held its rate at decades-high levels for more than a year.

How Overseas Interest Rates Impact the U.S. Economy

Why do interest rates in the U.K. matter to the U.S. economy? The answer is in the strengthening effect it has on the value of the dollar. With the U.S. federal funds rate set at 5.25% – 5.5%, investors can find a better deal on U.S. bonds, generally making U.S. dollars more valuable when compared with the currencies of other nations.

The British Pound (GBPUSD) and the Euro (EURUSD) slipped against the dollar in the immediate aftermath of the BOE decision.

A stronger dollar is good for travelers and importers, but exporters and companies like McDonald’s (MCD) that have significant operations in other countries can be hurt by a strong dollar value.

“With rates going down in Europe, investors will want to keep their money in the U.S. because they get a higher return. This pushes up the value of the dollar and pushes down the euro, which in turn increases inflationary pressures for Europe, partly offsetting the stimulus benefits of rate cuts,” said Jumana Saleheen, Vanguard’s chief economist for Europe.

However, there are risks attached to moving ahead of the Federal Reserve, said Roger Aliaga-Diaz, Vanguard’s chief economist for the Americas region. 

“Typically, other central banks take cues from the Fed given the implications of U.S. dollar flows for the stability of local currencies,” Aliaga-Diaz said.